Nigeria Fixed Income Weekly

Apologies for the radio silence. A lot has happened and I will spend the next few weeks playing catch-up starting today!

Tight funding continues to keep interbank rates elevated: Thus far in June 2021, short term interest rates have remained pressured in June with average open-buy-back and overnight rates at 15.9% and 16.2% respectively. The development continues to reflect a strain on liquidity as can be seen with continued bank activity in CBN’s discount window as well as increased repo market activity since April 2021. However, system liquidity has improved as non-bank holders of SPEB securities received cash when CBN rolled over at the end of May 2021. Effectively banking liquidity remains strained as CBN resorts to CRR as its preferred sterilization tool (vs OMO bills) which puts pressure on Tier II banks. While improvements in non-bank liquidity has helped calm things after severe pressures in recent months, rates remain at much higher levels than the near-zero levels we opened up to in 2021.

Figure 1: Overnight rates and Discount window/repo market activity

Source: CBN

NTB market remains broken, short squeeze induces a rally in bonds:  However, the front end of the curve remains trapped in the confusion of multiple yield levels. The 90-day SPEB traded at yield of 8.8% vs the 2.5% for the same tenor at the primary market auction during the week and 7% for the OMO bill of same tenor by the CBN. The divergence reflects the segmentation of the front end into foreign investors and banks (OMO) and domestic investors basically picking their habitat. Desperate money market funds (industry AUM sits at NGN700billion) will continue to provide strong bids for NTBs which has worked to prevent a convergence with the OMO bill level given the eat-what-you-kill nature of these auctions.

Elsewhere on bonds, yields compressed 25bps w/w driven by strong buying action on the long-end (>10year) by short sellers caught out by the decision of the DMO to replace the previously on-the-run 2045s with the illiquid 2050s. Though no data is available on short-interest positions across bonds, it would appear the active short positions were outsized relative to available long positions. I had noted that in February that the rule change which proscribed re-classifications in pension fund bond holdings from MTM to HTM and vice versa would limit activity in secondary bond markets. As we are seeing, it would appear these funds are now long-only with action at primary auctions. How does this explain the current bull run? There is no natural supplier of long dated bonds as pension funds have largely booked these positions in the HTM cluster which cannot be traded. With limited supply, the desperate shorts chased available offers (with the 2045s trading sub-13% at some point over the week) in a bid to cover their naked short positions. Under thin trading levels, the short squeeze worked to drive a swift retracement in yield levels ahead of the June 2021 bond auction.

Figure 2: Naira Yield Curve

Source: FMDQ, NBS.

Inflation slows on base effects in Food: The NBS released May CPI data which showed another deceleration in headline inflation to 17.93% (April: 18.12%) largely driven by softer food inflation relative to a pick-up in core inflation to 13%. The monthly trends show that farm produce slowed vs the rising trend over the preceding 12-month. Though this appears out of sync with everyday phenomenon, it is important to reiterate that it is the pace of increase that has slackened not that food prices are declining.

Looking ahead, assuming no changes in fuel or electricity prices and if the CBN somehow manages to regain control of the FX market by smothering the parallel market premium, inflation looks to have peaked in March as a much better outlook for the main food harvest in H2 2021 and large base effects will work to drive headline readings progressively lower. My sense is inflation slows towards 14-15% by year end.

Figure 3: 2021 Inflation Forecasts

Source: Author’s computation.

More Naira borrowings ahead as FG unveils supplementary budget: The finance ministry announced plans to seek legislative approval for a NGN896billion supplementary budget to cater primarily for security related expenditure (NGN770billion) as well as 30million covid-19 vaccines from Johnson & Johnson. To finance the outlay the Finance ministry will look to tap domestic debt markets for NGN723billion. This raises planned 2021 domestic borrowings to NGN2.8trillion (Gross NGN3.3trillion) and suggests there is room for strong supply over H2 2021. In terms of specifics the CBN, on behalf of the DMO, has sold NGN1.55trillion worth of NTB papers, which offset against NTB maturities of NGN1.28trillion implies net NTB borrowings of NGN274billion (53% on the 1yr tenor). Gross bond sales thus far stand at NGN1.08trillion implying total net borrowings over the period of NGN1.35trillion (64% of planned net sales). As this excludes the July 2021 bond maturities of NGN561billion, adding what is left to this number implies the DMO has potentially NGN1.3trillion left to sell.

(I use potentially as actual cash received might be higher depending on whether the bond is premium or discount, which possibly explains the decision to jettison the 2045 bond, though the 2035s and 2045s are also discount bonds but less steep than the 2045s). In terms of likely tenors over H2 2021, my suspicion is that DMO will still return to the 2045s and possibly re-introduce the 2037s.

Naira appreciates at the parallel market: Though the Naira remained steady at NGN411/$ in the investors & exporters window, the cash rate at the parallel market strengthened 1.6% w/w to NGN490/$. The pullback reflects fire-sale exits by speculators spooked by news that the CBN was planning to ramp up sales to the segment via banks and BDC operators. Despite higher oil prices, FX reserves maintained recent downtrend to USD33.8billion. In my view, a large Eurobond sale (USD5-6billion), alongside some devaluation towards fair value (NGN430-440/$) with modest increase in interest rates towards 13-14% would work to improve liquidity across Nigeria’s FX markets. All three events appear reasonable over 2021 just a question of timing.

The week ahead June 21-25

In the week ahead, system maturities are small with only NGN10billion in OMO bill maturities. That said, market focus will be on the outcome of the bond auction on Wednesday.

June 2020 bond auction: In its usual style, the DMO has NGN150billion on offer evenly split across the 2027, 2035 and 2050 bonds though markets would not be surprised in the event of an oversale. In view of the looming July 2021 maturities and slide in secondary market yields, demand is likely to be robust which raises the specter of desperate must-win bids driving yields lower. At May’s sale, the three papers on offer printed at 13.1% (2027), 14% (2035) and 14.2% (2049) which compares to the secondary market close of 12.65% (2027), 13.41% (2035) and 13.49% (2049s). My guess on likely stop rates are 2027s (12.9-13%), 2035 (13.5-13.6%) and 2050s (13.7%-13.9%).

One comment

  1. No need to apologise for free, sir.

    I appreciate your breakdowns anytime you can provide them.

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